3 Things to Know About Contract Termination Liability

One of my appropriations law students recently asked a great question about how to handle contract termination liability. This is one of those sticky subjects regarding the intersection of contract law and appropriations law, so I highly recommend always consulting your agency’s legal counsel and specific regulations.

Nevertheless, there are a few things to know about contract terminations that will help you better understand the concept and when to ask questions about it:

Termination, like a contract incentive, is considered a contingent liability. According to the GAO’s “Glossary of Terms Used in the Federal Budget Process,” a contingent liability is, “an existing condition, situation, or set of circumstances that poses the possibility of a loss to an agency that will ultimately be resolved when one or more events occur or fail to occur.”

A contingent liability does not create an actual liability (i.e., a legal obligation) until the contingency materializes—making the liability no longer contingent. In other words, contingent liabilities lack the certainty that is essential to the concept of an obligation.

And here’s the sticky part: Contingent liabilities pose a fiscal dilemma. Some agencies may choose to recognize the potential amount as a commitment. However, OMB advises that commitments for contingent liabilities must be conservative or not made at all. So, if you choose to record contingent liabilities, then you must track them closely, especially at the end of the year so that you can recognize any contingent liabilities that need to be adjusted or decommitted.

If you understand these three items, then you will be equipped to have conversations with all the right people should you ever find yourself dealing with a contract termination situation.